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enGot Bonds?http://www.fortnightly.com/fortnightly/2012/06/got-bonds
<div class="field field-name-field-import-deck field-type-text-long field-label-inline clearfix"><div class="field-label">Deck:&nbsp;</div><div class="field-items"><div class="field-item even"><p>MidAmerican’s Topaz solar financing proves that bond investors have an appetite for green investments.</p>
</div></div></div><div class="field field-name-field-import-byline field-type-text-long field-label-inline clearfix"><div class="field-label">Byline:&nbsp;</div><div class="field-items"><div class="field-item even"><p>Scott M. Gawlicki</p>
</div></div></div><div class="field field-name-field-import-category field-type-text field-label-inline clearfix"><div class="field-label">Category:&nbsp;</div><div class="field-items"><div class="field-item even">Business &amp; Money</div></div></div><div class="field field-name-field-import-bio field-type-text-long field-label-inline clearfix"><div class="field-label">Author Bio:&nbsp;</div><div class="field-items"><div class="field-item even"><p><b>Scott M. Gawlicki</b> is <i>Fortnightly’s</i> contributing editor based in Hartford, Conn.</p>
</div></div></div><div class="field field-name-field-import-volume field-type-node-reference field-label-inline clearfix"><div class="field-label">Magazine Volume:&nbsp;</div><div class="field-items"><div class="field-item even">Fortnightly - June 2012</div></div></div><div class="field field-name-body field-type-text-with-summary field-label-hidden"><div class="field-items"><div class="field-item even"><p>When MidAmerican Energy Holdings issued $850 million in bonds in February 2012 to finance construction of the massive 550-MW Topaz Solar photovoltaic (PV) farm, it raised more than a few eyebrows in the financial and renewable energy communities.</p>
<p>Not because Topaz, located in San Luis Obispo, Calif., will be one of the world’s largest solar PV farms when construction is completed in 2015; or that MidAmerican, a key energy component in Warren Buffet’s Berkshire Hathaway holding company, is itself investing roughly $1.2 billion, or 50 percent of the project’s cost.</p>
<p>No, the bond issue—structured as a rule-144a private placement—generated headlines for three reasons. First, it will fund the largest solar project ever to tap the capital markets for project finance without the backing of a government loan guarantee. Second, it was the first solar bond issue to be rated investment grade by the three big ratings agencies, Moody’s, Fitch, and Standard and Poor’s. And third, it was so heavily oversubscribed that MidAmerican plans to announce a follow-up issue worth roughly $400 million.</p>
<p>All of which has left a growing number of financial and power industry players asking: With an assortment of U.S. government supports falling by the wayside and European banks cutting back traditional project finance lending, might the bond markets become a more mainstream approach to renewable energy financing going forward?</p>
<p>Andrew Kinross, a Boston-based director of the energy practice at Navigant Consulting, certainly sees it that way. He observes that although FPL issued bonds as early as 2005 to finance wind project construction, no solar projects have been financed in the capital markets without a government loan guarantee. “The fact that the Topaz bonds were so heavily oversubscribed, and there are other solar projects currently under review by the rating agencies, demonstrates the appetite for solar projects,” Kinross says.</p>
<h4>Beating the Numbers</h4>
<p>From an investment standpoint, Topaz is about as good as it gets, which explains the appetite for the bond offering. Some of the rating agency highlights:</p>
<p>In terms of credit quality, MidAmerican Energy Holdings is part of Berkshire Hathaway and has a 50 percent equity stake in the project. In its rating report Fitch describes Berkshire as financially capable of contributing the full equity financing for the Topaz project, if required. In January MidAmerican created MidAmerican Renewables LLC to support the company’s move into the unregulated renewable energy market.</p>
<p>The power is being purchased by an investment grade utility, Pacific Gas and Electric (PG&amp;E). The 25-year fixed-price power purchase agreement will help PG&amp;E comply with California’s mandate that 33 percent of its power supply must come from renewable sources by 2020.</p>
<p>First Solar will construct the plant under a fixed-price, date-certain engineering, procurement, and construction (EPC) contract, and then operate the plant under a 25-year O&amp;M agreement with termination provisions every five years at the option of Topaz.</p>
<p>Fitch found the project to have limited completion risk due to First Solar’s experience building other plants, including the 20-MW Sarnia, Ontario, plant and its 60-MW expansion, plus the 10-MW El Dorado plant in Boulder City, Nev., and the 21-MW Blythe project in Riverside County, Calif., all using First Solar technology. According to the rating agency, the projects were built at a balance-of-plant cost less than budgeted and with no change orders. Further, it said that if First Solar is unable to meet its obligations, “there are sufficient alternate suppliers to complete the project at a cost and schedule that would not significantly erode cash flows.”</p>
<p>The milestones in the EPC agreement and PPA effectively mitigate potential delay risks. The EPC agreement includes guaranteed capacity milestones, as well as milestones for completion of each PV block, with sufficient liquidated damages (LD) due for failure to meet the prescribed targets.</p>
<p>In addition, the EPC agreement includes guaranteed capacity levels to reach substantial completion, largely mitigating a shortfall in the expected nameplate capacity. Under the PPA, the guaranteed commercial operation date provides a three-month cushion after the guaranteed substantial completion date in the EPC agreement, which Fitch views sufficient for a PV project. Fitch also considers the thin-film PV technology employed in Topaz, with CdTe as the semiconductor, commercially proven with relatively low technology risk.</p>
<p>Choosing bond financing, Kinross points out, brought MidAmerican numerous benefits. With debt at 5.75 percent, for example, the pricing is nearly 3.75 percent higher than Treasury bills, which satisfied investors. At the same time, 5.75 percent is lower than bank financing rates at 6 or 6.5 percent.</p>
<p>Further, Kinross says, lenders typically seek a debt service coverage ratio of 1.4 or above from a project finance candidate. “With Topaz, the base case coverage ratio is 1.4, but that’s based on conservative assumptions, so it could be 1.5.,” he says. “Many of the assumptions used in the analysis are conservative.” For example, they anticipate a 0.9-percent panel degradation figure vs. the typical 0.7 percent, and availability at 97 percent vs. the typical 98 to 99 percent. “So the project should be able to beat the numbers,” Kinross says. “If it operates above the base case the quality of the investment will be even higher.”</p>
<h4>Building with Bonds</h4>
<p>The Topaz offering isn’t without precedent with regards to renewable energy finance. For instance, some $1.2 billion in private debt and equity was raised to finance the nine SEGS concentrated solar projects in southern California back in the 1980s and 1990s. And, as Kinross pointed out, FPL Energy sold a $380 million bond offering in 2005 for seven wind projects totaling 697 MW in six states. S&amp;P also assigned the senior secured debt associated with that project a BBB- rating.</p>
<p>More recently, bonds, in concert with the recently expired Financial Institution Public Partnership (FIPP) program, have been used to finance a number of PV and concentrated solar projects. The Genesis project, a 250 MW concentrated solar facility being developed by NextEra Energy Resources in Riverside County, Calif., used a $681 million federal loan guarantee to secure $852 million in financing in 2011.</p>
<p>NRG Energy’s 290-MW Agua Caliente PV project in Yuma County, Ariz.—of which MidAmerican recently bought a 49 percent stake—received a partial loan guarantee in August 2011. And a number of comparatively small solar PV projects reportedly have secured private bond financing deals in recent years.</p>
<p>“Renewable energy projects aren’t new to bond financing. We’ve looked at U.S. wind and biomass projects, and some PV projects outside the U.S., as well as the renewable projects recently executed with loan guarantees provided by (the FIPP),” says Cynthia Howells, director of global infrastructure and project finance at Fitch, which rated the Topaz bonds at BBB- and will soon release a special report on solar technologies.</p>
<p>How the expiration of the loan guarantees will affect renewable financing remains to be seen. Other challenges include a limited number of tax equity investors; the expiration of the Treasury cash grant program; and the impending expiration of the wind energy production tax credit (PTC) at the end of 2012. However, solar PV projects still can benefit from the federal investment tax credit until 2016.</p>
<p>“Financing solar projects really caught on through the [loan guarantee] program. Will the bond market be open to more solar PV projects going forward? It depends on the deal,” Howells says. “Even with the investment tax credit in place until 2016, you still need to finance 70 to 80 percent of the project. So yes, it could be bond financing, especially if the European banks continue to pull back from project finance lending.”</p>
<h4>Banking on Tax Equity</h4>
<p>European banks, which as recently as a year ago dominated the U.S. project finance market, have substantially curtailed their lending due to Europe’s ongoing fiscal problems and proposed measures under Basel III—the Basel Committee on Banking Supervision’s proposed new global standards for bank liquidity and capital adequacy.</p>
<p>Though Asian banks—particularly Japanese banks—have begun to fill some of the void, experts say the bank finance market is still anything but robust. It remains to be seen whether European project finance lending ever will return to previous levels.</p>
<p>Until recently, European banks generally had a greater acceptance of new technology and the related construction risks, and typically offered U.S. renewable developers competitive, long-tenor loans at favorable rates. Further, bank loans also come without a bond issue’s carrying costs. Because a bond issue kicks in at the financial closing, the developer must pay interest on the entire loan during the construction period, explains Trevor D’Olier-Lees, a credit analyst with Standard &amp; Poor’s, which rated the Topaz bonds BBB-. </p>
<p>“The construction period is relatively short, usually from one to two years, but you’re paying maximum interest during that time. With a bank loan, instead of borrowing the full amount up front, you draw it down gradually and only pay interest on what you draw down,” D’Olier-Lees explains. “We’ve seen deals where had it been a bond issue, we might have rated it BB or BB+. But the banks were okay with the risk level and the developer ended up with a better internal rate of return.”</p>
<p>More importantly, D’Olier-Lees says the potential for stricter regulations governing bank lending under Basel III could greatly impact European bank lending. Basel III is expected to be ratified by the end of this year and banks have begun lobbying heavily against the measures. While each country ultimately will set its own standards, D’Olier-Lees says Basel III could result in a double-whammy for prospective borrowers: higher funding costs and lower availability of long-term bank credit. If that happens, he says, capital market finance could become the more attractive option.</p>
<p>“I see a sea change in project finance funding due to the [future] high cost of project finance loans. European banks are already pulling back from the traditional long-tenor project finance loans,” he says. “I think the larger projects will go to the capital markets because the banks will have less money to lend. And directionally that already appears to be happening. We’ve seen a number of banks exploring capital market solutions, and when we ask them, ‘Why are you here?’ they say ‘Basel III.’ We also have more banks coming to us and saying they’re looking for a construction loan with a capital market takeout.”</p>
<p>Though it’s improved somewhat, the tax equity market still appears limited as well. With the DOE solar tax credit equal to 30 percent of the cost of new installations through 2016, developers traditionally have brought in partners seeking tax relief to take an equity position in the project. However, when the financial crisis hit in 2008, the number of tax equity investors all but evaporated.</p>
<p>As part of the federal government’s stimulus package, the Department of Treasury implemented the cash grant program, which provided renewable power developers a grant up to 30 percent of the cost of the project to attract investors. But the cash grant program expired in 2011, and while the number of potential tax equity candidates has grown, the number of renewable project developers seeking tax equity investors far outweighs supply.</p>
<p>“Right now there are more projects than tax equity investors, but that’s always been the case. In 2008 the tax equity market contracted significantly due to post-crisis losses. Some investors cut back and others dropped out completely,” says Marshal Salant, head of alternative energy finance at Citigroup. “The number of tax equity investors increased a bit over the past year or so, as previous players returned and a few new buyers emerged, but the dollar volume in 2011 was not all the way back to 2007 levels.”</p>
<p>Therefore, while the dollar amount of tax equity required by developers continued to grow, Salant says there was a significant supply-demand imbalance last year. And although he’s optimistic that a few new buyers will join the market and a number of existing participants will invest more, it still won’t be enough to offset the loss of the cash grants.</p>
<p>“The utility-scale projects—the mega solar projects for instance—can and will soak up a major portion of the tax equity dollars, and there is significant demand from distributed solar and rooftop developers too. And there are all the wind deals rushing in to close before the PTC expires,” Salant says.</p>
<h4>Size Matters</h4>
<p>If capital market financing does indeed become more mainstream in the renewable energy space, will there be a limit to how small the project can be?</p>
<p>“I think anything under $100 million starts to be too small for the public bond markets, but we do see smaller deals getting done in the private market. I would say $50 million is the absolute cut-off for a private bond deal,” Howells says.</p>
<p>Obviously the larger the project size, the greater amount of debt offered to investors. That was certainly a key to the Topaz offering. As a result, developers might attempt to gather a handful of smaller projects—perhaps with the same equipment supplier and EPC contractor—and finance the projects as a single package.</p>
<p>Whether that will happen depends on markets and policy trends. Navigant projects that without a PTC extension, the U.S. wind market will shrink to 2 GW in 2013, down from more than 8 GW in 2012. At the same time, it estimates the U.S. PV utility scale market will grow from about 700 MW in 2011 to about 2,500 MW in 2016, with total capital requirements of $3 to $4 billion in 2012 alone. Though investor appetite for solar bonds appears to be strong, it’s still early.</p>
<p>“Based on what we’ve seen and the financial metrics the banks have discussed with us, there are a number of [$100 million-plus] projects in the works this year, and developers are looking at their financing options,” D’Olier-Lees says. “They have signed PPAs in place and we think they will probably lean towards a bond issue. But of course nothing is done until it’s done.”<i> </i></p>
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</div></div></div><div class="field field-name-field-article-category field-type-taxonomy-term-reference field-label-above clearfix"><h3 class="field-label">Category (Actual): </h3><ul class="links"><li class="taxonomy-term-reference-0"><a href="/article-categories/renewables-solar-11505">Solar</a></li><li class="taxonomy-term-reference-1"><a href="/article-categories/bonds-debt-markets">Bonds / Debt Markets</a></li></ul></div><div class="field field-name-field-members-only field-type-list-boolean field-label-above"><div class="field-label">Viewable to All?:&nbsp;</div><div class="field-items"><div class="field-item even"></div></div></div><div class="field field-name-field-article-featured field-type-list-boolean field-label-above"><div class="field-label">Is Featured?:&nbsp;</div><div class="field-items"><div class="field-item even"></div></div></div><div class="field field-name-field-department field-type-taxonomy-term-reference field-label-above clearfix"><h3 class="field-label">Department: </h3><ul class="links"><li class="taxonomy-term-reference-0"><a href="/department/business-money">Business &amp; Money</a></li></ul></div><div class="field field-name-field-image-picture field-type-image field-label-above"><div class="field-label">Image Picture:&nbsp;</div><div class="field-items"><div class="field-item even"><img src="http://www.fortnightly.com/sites/default/files/article_images/1206/images/1206-BIZ.jpg" width="1158" height="1500" alt="" /></div></div></div><div class="field field-name-field-fortnightly-40 field-type-list-boolean field-label-above"><div class="field-label">Is Fortnightly 40?:&nbsp;</div><div class="field-items"><div class="field-item even"></div></div></div><div class="field field-name-field-law-lawyers field-type-list-boolean field-label-above"><div class="field-label">Is Law &amp; Lawyers:&nbsp;</div><div class="field-items"><div class="field-item even"></div></div></div><div class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above clearfix">
<div class="field-label">Tags:&nbsp;</div>
<div class="field-items">
<a href="/tags/midamerican">MidAmerican</a><span class="pur_comma">, </span><a href="/tags/topaz">Topaz</a><span class="pur_comma">, </span><a href="/tags/solar">Solar</a><span class="pur_comma">, </span><a href="/tags/financing">Financing</a><span class="pur_comma">, </span><a href="/tags/photovoltaic">Photovoltaic</a><span class="pur_comma">, </span><a href="/tags/pv">PV</a><span class="pur_comma">, </span><a href="/tags/warren-buffet">Warren Buffet</a><span class="pur_comma">, </span><a href="/tags/berkshire-hathaway">Berkshire Hathaway</a><span class="pur_comma">, </span><a href="/tags/144a">144a</a><span class="pur_comma">, </span><a href="/tags/moody%E2%80%99s">Moody’s</a><span class="pur_comma">, </span><a href="/tags/fitch">Fitch</a><span class="pur_comma">, </span><a href="/tags/standard-and-poor%E2%80%99s">Standard and Poor’s</a><span class="pur_comma">, </span><a href="/tags/andew-kinross">Andew Kinross</a><span class="pur_comma">, </span><a href="/tags/navigant-consulting">Navigant Consulting</a><span class="pur_comma">, </span><a href="/tags/fpl">FPL</a><span class="pur_comma">, </span><a href="/tags/florida-power-light">Florida Power &amp; Light</a><span class="pur_comma">, </span><a href="/tags/pacific-gas-and-electric">Pacific Gas and Electric</a><span class="pur_comma">, </span><a href="/tags/pge">PG&amp;E</a><span class="pur_comma">, </span><a href="/tags/first-solar">First Solar</a><span class="pur_comma">, </span><a href="/tags/engineering-procurement-and-construction">Engineering procurement and construction</a><span class="pur_comma">, </span><a href="/tags/epc">EPC</a><span class="pur_comma">, </span><a href="/tags/sarnia">Sarnia</a><span class="pur_comma">, </span><a href="/tags/el-dorado">El Dorado</a><span class="pur_comma">, </span><a href="/tags/blythe">Blythe</a><span class="pur_comma">, </span><a href="/tags/liquidated-damages">Liquidated damages</a><span class="pur_comma">, </span><a href="/tags/ld">LD</a><span class="pur_comma">, </span><a href="/tags/thin-film">Thin-film</a><span class="pur_comma">, </span><a href="/tags/segs">SEGS</a><span class="pur_comma">, </span><a href="/tags/solar-electric-generating-station">Solar Electric Generating Station</a><span class="pur_comma">, </span><a href="/tags/financial-institution-public-partnership">Financial Institution Public Partnership</a><span class="pur_comma">, </span><a href="/tags/fipp">FIPP</a><span class="pur_comma">, </span><a href="/tags/nextera">NextEra</a><span class="pur_comma">, </span><a href="/tags/agua-caliente">Agua Caliente</a><span class="pur_comma">, </span><a href="/tags/cynthia-howells">Cynthia Howells</a><span class="pur_comma">, </span><a href="/tags/production-tax-credit">Production tax credit</a><span class="pur_comma">, </span><a href="/tags/ptc">PTC</a><span class="pur_comma">, </span><a href="/tags/basell">Basell</a><span class="pur_comma">, </span><a href="/tags/trevor-d%E2%80%99olier-lees">Trevor D’Olier-Lees</a><span class="pur_comma">, </span><a href="/tags/treasury">Treasury</a><span class="pur_comma">, </span><a href="/tags/marshal-salant">Marshal Salant</a><span class="pur_comma">, </span><a href="/tags/citigroup">Citigroup</a> </div>
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Fri, 01 Jun 2012 04:00:00 +0000puradmin14594 at http://www.fortnightly.com